Averaging Down and Scaling Up; Which One Works?

I wanted to write one article about the most terrible mistakes that traders make. But, yesterday I decided to write one separate article for each mistake, because I thought it is better to describe each mistake in details in one article.

Yesterday, I talked about taking a risk in trading and the way you can increase the level of the risk you take. I recommend you to read that article, because it is not only about risking. It tells you how to grow your account:What Is the Proper Risk Reward Ratio in Trading?

Averaging Down is one of the other terrible mistakes that traders make. Most of the traders wipe out their accounts through averaging down.

Before you read the rest of this article... Submit your email to receive our eBook for Free:

What Is Averaging Down?

Averaging down is adding to a losing position. You take a position, but it goes against you. So you take another position while the first position is still open, with this hope that the price turns around and the second position goes to profit and you close the fist position at breakeven. Sometimes the market is kind enough to do it for you, but sometimes it keeps on going against you. So you average down again and take another position while the first two positions are still open. You do this until you get margin call which means you can close your open positions, but you can not take any new positions anymore.

If the price keeps on going against you, then you will reach the stop out level, and the platform starts closing your losing positions. It starts from the biggest losing position, and closes the positions one by one. When this happens, usually your whole account will be wiped out.

Why Do Traders Average Down?

A professional trader never makes such a terrible mistake. It can happen to a professional trader that he takes a position that goes against him. However, there is always a reasonable stop loss there to protect his capital. He gets out with a small loss that can be easily recovered with the next winning position.

The traders who average down, are not professional and have not learned how to trade yet. They are afraid of losing, and want to be winners all the time. So they don’t set any stop loss, and they average down when the market goes against them. Sometimes they succeed to get out with profit, but if the price keeps on going against them just once, they will blow up the whole account. This is something that the traders who don’t set any stop loss experience at least a few times, before they give up on trading.

You should accept and admit that you can not open a live account and double it every month while you not only have not properly learned the technical aspect of the trading, but also you have not built your discipline and confidence, and you have not mastered your trading system yet. Opening a live account under such a condition is like going to casino with $5000 in your pocket, and being hopeful that you get out of the casino with $50,000.

So the conclusion is that averaging down comes from the lack of knowledge, experience, patience and discipline.

What Is Scaling Up?

Scaling up is adding to a winning position. You open a position and it makes money, so that you take another position while the first position is still open.

I have read it in some articles that they recommend the traders to scale up, but obviously those articles are not written by real traders.

You don’t have to scale up when your position goes to a reasonable profit. You can move the stop loss to breakeven and let your profit run. Scaling up is not a good strategy because you never know when the price turns around. It is possible that when you take one more position, then the price turn around suddenly and goes against you. Then you will have to get out with loss. So I don’t recommend you to scale up. I have never done it myself.

Hi Chris, could i ask you to review this analysis? if you could please express your thought process of assessing these charts for setups?

1. GBPJPY – continuation trade off mid BB, strong bounce and good close after indecision candles. MACD and RSI pointing up. previous downtrend line for the consolidation broken up. the EURJPY doesnt confirm this setup, but at the same time the EURGBP is strongly bearish indicating that EUR is taking a hit right now.

2. EURGBP – strong bearish move with strong close just outside lower BB, but no entry because there was no real consolidation at the BB mid band before the downmove thus downmove over-extended and can pull back.

3. USDCAD – looks like a decent bounce but the downmove was a strong one, that broke the mid BB and the up trend line. Where price is sitting now is a risky spot because of indecision at the end of up trend. So although looks like a sorta good trade setup and possible to go up to retest broken trend line / BB, its a too risky setup.

4. GBPCAD – strong signs of reversal but relatively weak compared to strength of the down move, and the downtrend is still fresh therefore too risk to take reversal trade.

1. This is a buy signal formed above the BB middle band, but it is not a continuation signal, because there is no uptrend there, and GBP/JPY is ranging.

2. Honestly, I don’t understand what you are saying about EUR/GBP. All I can say is that there is no formed or forming trade setup there 🙂

3. It looks like a good trade setup. However, if the AUD/JPY long trade setup’s strength is 100, the current USD/CAD strength is 70-80. So I agree with you that its risk is a little high.

4. Yes, I agree. Above all, both USD/CAD and GBP/CAD are Canadian Dollar cross currency pairs, and when it comes to CAD both of these pairs form the same trade setup. However, we should trade only one of them, not both, because if the trade setup is formed because of the CAD fundamentals, then if one of the pairs goes against us, the other one will do the same.

Thanks for the replies Chris.
1. How strong a signal is the current GBPJPY signal? I will call this a ‘Zone 3’ signal (As per your article: How to Use Bollinger Bands® in and Stock Trading). I am seeing these Zone 3 signals quite a lot when reviewing daily price charts – they seem to be quite reliable if the signal candle is strong with a strong close. These seem to happen before the price ‘climbs’ onto the outer BBs.

2. Sorry i wasnt clear about my thoughts on this one! I suppose what im asking about EURGBP is: prior to the current strong bear candle, If there was a consolidation area which properly tested the mid BB as a resistance area, would the current strongly bearish bar be more likely to be a sell signal?

3. Why is the AUDJPY setup stronger than the USDCAD? is it only that the length of the AUDJPY doji tail is longer compared to the preceding bearish bars? or is there something else ?

1. GBP/JPY would be known as a strong continuation signal if we already had a strong trend. There is no trend now. So what we have there is just a buy signal formed above the 20SMA. Its strength is 50/50. It can make the price go up, and it can mean absolutely nothing. When the market is ranging, it means money is not flooding to the market and the market is not liquid. Under such a condition, signals and trade setups like the one we have now can be meaningless.

2. Yes. Also, I see that there is a small support which is already broken. So the current bearish candle is really a continuation, but formed differently, through a support breakout.

3. I am going to write a post about this and will compare these setups.

1. i dont understand how we can have this GBPJPY setup in a strong uptrend – i thought this signal is formed as the first congestion above the mid BB, after a reversal has happened. e.g. in the current USDCAD chart, the downtrend ended, and the BB mid band was broken and became support (‘zone 3’ as per the BB article ‘conservative investors wait for zone3 to form before entering’). Or, do you refer to the idea that IF there is a strong reversal first, and then the congestion above mid BB forms, Then conservative investors enter based on the strong reversal AND the congestion?

2. Could i ask please how you define strong trend vs trend vs ranging market (there are many opinions on the net). how far back do you look to define the dominant trend?
2A. You refer to the USDCAD hammer as being a signal formed at the bottom of a bear market (do you refer to the bear market which went from mid march until end of june?)
2B. You refer to the GBPCAD dark cloud cover as formed in a ranging market – which means you refer to the range as from mid march until end june again?
thank you

Chris thank you very much, and just keep doing what you are doing now… i believe its my (and others) perspective that needs tuning – the way you explain is not a problem. You explain in simple terms but i still read several times to absorb the simple truth in what you are explaining. you have answered all the questions i had on this particular post thread. Other questions will definitely be asked… like you say step by step! thanks for your patience!

Does scaling up make sense, when I catch a trend, like EUR/USD short, and add to my position, when a continuation setup forms (at points where I would enter if I was not in yet)? This way I actually reinvest a part of my profit into the trend, to make even more of it. I cannot see why this is bad.
Thanks,
Otto